Prosperity Bank (PRSP) is a recommendation that we were working on for the last week or so. We initiated coverage at $36.18 with a $45 price target. PRSP ranked # 2 versus 220 financial names according to our 155-variable computer model. The stock also passed fundamental and subjective overlays applied last week. Unfortunately the shares jumped from < $33 to > $36 as we were doing our research and waiting for a callback from one of the executives there.
I did speak with President Rollins today and am ready to step in here. Because of the recent share price move, we can only attach our second-highest ranking (Accumulate) to this name. If the shares come back down to $33-$34 in a market correction, we would raise our rating on this name.
PRSP is a Texas bank with 175 branches. PRSP is willing to go out-of-state if the opportunity presents itself, but there are no current plans to do so. The truth of the matter is that PRSP only has 2% market share in Texas and can easily double or triple its size (to 4%-6%), so it does not need to leave Texas.
The company's weak ROE can be disregarded. PRSP should be valued more on its return on average tangible common equity, which is 27.6 percent. The multiple to tangible book value is high at 3X, but it has always been high and can be overlooked. In fact, 3X is at the low end of its historical P/TBV multiple of 2X-6X. Price/Book is currently at 1.2X. PRSP has historically traded at 1.0X-1.8X during the last five years (excluding outliers).
BB&T (BBT) recently went on record stating that it is looking to acquire a Texas-based bank; PRSP is one of the few under consideration. That being said, BB&T has been saying this for a few years now, and this takeover speculation carries no weight in this recommendation.
Earnings for PRSP in the last seven years were: $1.36, $1.58, $1.77, $1.93, $2.09, $2.06 and $2.40. Excluding a one-time charge in 2008, the $2.06 figure would have topped the $2.09 from 2007. Estimates for 2010 are $2.71; for 2011, estimates are for $2.75. Our $45 target is 15X a $3.00 estimate for 2012-2013. PRSP has historically traded at 12X-18X (excluding outliers).
The PRSP share price doubled from $7.50 in 2000 to $15 in 2002. By 2005, it doubled again to $30. We do expect to see $45 in this name within two years; that is near where the shares traded as recently as April 2010. The upside is ~25% from here and the dividend yield is 2.0% (recently raised 13% to $0.175 per quarter).
The company reported Q3 on October 22. For the three months ended September 30, 2010, net income was $32.16 million, compared with $29.32 million for the same period in 2009. Net income per diluted common share was $0.69 for the three months ended September 30, 2010, and $0.63 for the same period in 2009. Returns on average assets, average common equity and average tangible common equity for the three months ended September 30, 2010 were 1.36%, 9.06% and 27.62%, respectively. Prosperity's efficiency ratio (excluding net gains and losses on the sale of assets) was 45.35% for the three months ended September 30, 2010.
Non-performing assets totaled $20.700 million or 0.26% of average earning assets at September 30, 2010, compared with $21.920 million or 0.29% of average earning assets at September 30, 2009 and $21.856 million or 0.27% of average earnings assets at June 30, 2010. The allowance for credit losses was 1.50% of total loans at September 30, 2010, compared with 1.39% at September 30, 2009 and 1.54% of total loans at June 30, 2010.
PRSP will be impacted by overdraft rules going into effect in Q3 2011, but the damage should not be significant and is already priced into the shares.
The company recently announced that it would increase its dividend, indicating that it expects to continue to perform well going forward. Prosperity Bancshares has succeeded in performing exceptionally well during the credit crisis, able to maintain relatively higher asset quality than competitors. Non-performing assets (those including loans past-due 90 days or more or in non-accrual status, and repossessed real estate) made up only 0.22% of total assets as of the end of Q3. To compare, this figure averaged 3.31% for all U.S. banks as of the end of Q2.
Net charge-offs for the company were also encouraging, totaling $4.4 million for Q3, with loan-loss reserves at $3.0 million, indicating a release of $1.4 million in loan-loss reserves over that quarter. This did not have a material impact on the company’s earnings. Net charge-offs to loans was only 0.13 percent. Prosperity is well capitalized, with a Tier 1 leverage ratio of ~6.5% and a total risk-based capital ratio of ~14.5%, compared to the 5.0% and 10.0% considered strong by regulators.
We would begin building a position here with 25% upside from the current quote; we would get aggressive on a correction to $34-$33 (32%-36% upside to our $45 target from those lower price points).